Friday, January 18, 2008

As we may have noticed, we are in or about to enter a recession - brought on largely by the collapse of the sub-prime mortgage companies. A big part of the problem is a wide spread trend of living beyond our means both at the personal and governmental levels. Personally, Americans are swimming in debt - credit cards, mortgages, home equity loans, car loans, student loans. Of those kinds of debt only student loans and mortgages can be thought of investments for the future. Credit cards, home equity loans and car loans are merely consumption with deferred payment. When interest rates were low, the incentives to incur such debt for consumption's sake were high. Interest rates are rising now and people large amounts of this kind of debt and those who over leveraged on the other kinds of debt, are facing serious problems.

But that isn't the only cause. The Bush administration has chosen an economic path that combines unrestrained and unpredictable spending (largely on the war) with significant reductions in revenue through tax cuts. The result is that the U.S. Government borrows hundreds of billions of dollars (about 250 billion in 2005) to make up the short fall. Also as of 2005, the US debt/GDP ratio exceeded the amount permitted to E.U. Member States for entrance into the Monetary Union. That excess isn't by much but it is unprecedented, I believe. In any case, this massive increase in US government debt is sucking up capital from the market, exacerbating the problems caused by the sub-prime mortgage crisis. The high level of U.S. debt is a major cause of the increasing interest rates that are at the root of the foreclosures associated with the sub-prime lending crisis.

So today, George W. Bush announced that his proposed response to the recession is ....drum roll please....MORE TAX CUTS! The reasoning is that by injecting more capital into the market, tax cuts would goose the economy. In the short term it would probably work. But in the medium term such a move - if not followed up with a major reduction in spending (preferably by ending the war) - would worsen the underlying causes of the recession.

7 comments:

You are in good company, RbR. In his testimony to Congress yesterday, Federal Reserve Chairman Ben Bernanke said almost exactly what you did: that a "stimulus package" would likely work in the short run, but it must be immediate and fairly large, and must not be permanent (e.g. tax cuts) because that would exacerbate debt problems.

Bernanke did not, however, say that we were in a recession or that we would soon be in one: he warned only of slowing growth.

Actually, LTG, home equity loans CAN be used for wise investments in home improvement. But I know people who have used home equity loans to consolidate credit card debt and many people make improvements to homes that will never realize enough appreciation to recoup the investment.

I am surprised no one has pointed out that G.W. Bush's response to the situation may be more political than anything else. For starters, he only needs a stimulus to work until November. No sense in hurting the Republican presidential candidates more than they are hurting themselves anyway.

It doesn't help that the head of Iraqi military forces came out and said that his troops aren't that great and it will take another 4-5 years of US investment to get them up to snuff.

It will be up to the next president and the next Congress to fix the budget problem. So when candidates stand up and talk about universal health care, it is wishful thinking because so long as Iraq is sucking us dry, there isn't going to be funds for such a scheme- much less anything else.

The economy is still resting on the American consumer. And the reason you don't see consumer spending in the toilet is because there is zero incentive to save. And putting $1000 bucks away for a year earns you $40 in interested that will be taxed at 20%, it is hardly worth the effort. Might as well spend it.

Since no one can seem to save a nest egg the good old fashioned way, we will continue to be mired in consumer debt. I am willing to bet that if Americans have savings at all, it is pretty much in a 401K or IRAs. And the only reason they have that is because there are huge disincentives to early withdrawal. But no worries, in the great American tradition, you can even borrow against that meager account for a home or car purchase.

I don't believe Americans have low savings because of a lack of virtue. I think that the cost of living has been skyrocketing, but the CPI doesn't capture it because the cost is in education, health care, and housing. As a consequence, most Americans are faced with, in effect, declining incomes. The average price of a house is beyond the ability of the average person to afford - way beyond. A family earning $250K in annual income can, in many parts of the country, barely afford a house. That is not hyperbole or a joke - I can tell you this first hand. When incomes are in decline, people don't save - they borrow. When people can't afford to save, they don't. It doesn't help that taxes in this country are like a bell curve, with people earning around $100-$200K in income paying the highest % of their income to the government. This group also is likely to have very large student loans to pay off.

Moroever, the new generation of the middle class -those entering their 30s with good jobs - are finding that we can't afford all the things that our parents largely took for granted as the mark of the middle class. We enter life with huge debts (In the 1980s, our boomer parents decided not to pay taxes to support state universities anymore) and then face higher obstacles than ever before. Turning this around will take courage. It may also take another economic depression, and that may be coming, sadly.

I should add that one of the reasons my family are not supporting Clinton anymore is that we are both sick of the baby boomer generation self-centered attitudes that led them to demand all the government services for themselves in the 1960s and 1970s, then to abandon everything in the 1980s and 1990s for tax cuts and gated communities. Boomers have had their chance. The "me" generation screwed everything up for the rest of us. Instead of investing the great wealth built up during the post-WWII period, they spent it all and left us with massive federal debt, crumbling infrastructure, and the like. This wasn't fair payment for the good they did in the 1960s.